California Water Service Group (CWT) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the California Water Service Group third-quarter 2005 earnings results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Robert W. Foy, Chairman of the Board. Mr. Foy, you may begin.

Good afternoon, ladies and gentlemen. It gives me a great deal of pleasure to introduce you to John S. Tootle, our acting Vice President, Chief Financial Officer and Treasurer. John has been with Cal Water for the past five years. Some of you may remember John from his days at Dominguez Water, where he held similar responsibilities. John joined Cal Water following a merger, our merger with Dominguez.

Having said all that, let's get started. John, why don't you share financial results for these good folks, please?

Good afternoon. Today, I will be discussing the 2005 third-quarter results for Cal Water. We will also be providing an update on several other items, such as regulatory matters, capital expenditures, financing plan and the dividend approved most recently by the Board. Then we will open up for questions from the analysts.

Before I get started, I would like to take care of some legal matters and read the following forward-looking statement. As an introduction to the information we will be discussing, please be aware that some of our comments can be considered forward-looking statements as defined by the federal securities laws and as outlined in the Company's SEC filings. As such, the forward-looking statements are based on currently available information and management's assumptions, expectations, estimates. However, actual results may vary significantly.

Risk factors that could cause actual results to vary from expectations are described in the Company's filings with the SEC. These factors are also available in yesterday's earnings release, which can be viewed from our website at www.calwatergroup.com, and calwatergroup is one word.

Now let me look at the third-quarter results, 2005 versus 2004. Pleased to announce that our revenues were up $4 million, 4%, to 101 million. The primary cause of the increase in revenues was due to rate increases of approximately 4.4 million, of which 3.5 million are permanent, and 900,000 are temporary.

Offsetting the increase was a decrease in customer usage. Customer usage, as you know, has been down for the whole year, and the adverse cooler weather conditions I think have conditioned our customers. In Southern California, where I have been most of this quarter, I can tell you that we never did have a string of hot days. It was overcast most of the time, and as a result, people just have not basically started using water. New customer growth accounted for a 1.2 million increase in the revenues, and that's an increase in customers of about 1.3% from last year.

I'd like to now turn to the operating costs. Operating costs are up about 2.4 million, or about 3%. Water production costs were actually down; they dropped 1% to about 46 million -- or 46.808 billion gallons. Water production costs were down in terms of dollars by 800,000. This was primarily driven to lower usage and some price reductions.

In purchased water, we had a price reduction from the Hetch Hetchy for our northern district systems. The water credits from wholesalers were about the same as last year. Purchase power was lower $800,000, and that was primarily due to a price reduction by PG&E. Pump tax were also lower by about $200,000.

The mix of production, which dramatically can influence that overall production number, has purchased water, which is generally higher-priced, decreased from 46.5 to 45.9%. Well production increased to 50.8 from 49.9. Surface water production was about the same, about 3%. All of our subsidiaries are 100% on well water.

If you look at the margin, which is the net of the revenues less these water costs, that number increased by about 8.5% or 4.9 million. And of course, that was due to the increase in the revenues, and the lower overall water production costs.

I'm also pleased to announce that the other operating costs were primarily flat. Payroll was up about 800,000, but it was offset by lower worker comp costs of 300,000 and lower pension costs of about 600,000. This quarter, we booked a true-up with our pension expense based off of providing our actuary with consensus data, and that accounted for about $500,000 adjustment downwards in the pension cost.

Our maintenance expense was up slightly, and there was no particular item -- it was up about 200,000. Depreciation and amortization went up 800,000, and that's primarily due to a higher capital base off of our 2004 capital expenditures, but we also had a higher depreciation rate for eight districts that we filed last year and got our decision in July of this year. The commission allowed us a recovery rate at -- effective recovery rate at 2.7% versus 2.5% in the past.

The federal and state income taxes are up 1.9 million, and that's due to the higher taxable income. Property and taxes from other than income taxes were up $400,000, and that's again due to a higher capital base.

Our nonregulatory income was up by 700,000, and that was due to some sales of property in Chico, where last year for this period we did not have any property sales.

Interest expense is higher, and it's primarily due to less capitalized interest than last year. We recorded an adjustment on capitalized interest in the third quarter, which we did not do in this quarter.

The weighted-average shares slightly increased, but it had a negligible impact on our per-share income. Overall, our diluted earnings per share were $0.71 per share, comparing to $0.59 per share. This is an increase of $0.12 per share.

In review, the big items were the rate increase, the lower water production cost, flat operating cost, and the Chico non-utility property sales. Of course, this was all offset by higher income taxes on the higher pretax income.

For the nine months, earnings per share were $1.16, compared to $1.27, primarily due to the dilution of common shares outstanding due to a share issuance in June of 2004, and that accounts for about $0.06 of the decrease. Earnings from operation accounts for about 7% of the decrease, and that's primarily due to the lower customer usage that I referred to earlier this year because of the adverse weather conditions in California, with -- I'm sure you're all aware, we hit record precipitation in most of the states. These were offset by a slightly higher amount of income from non-utility property sales of about $0.02.

With this, at this point, I'm going to turn it back over to Bob, and let him talk to you about where we are with our current rate filing.

On August 8 of this year, Cal Water filed a general rate increase, more commonly known as GRCs, for eight districts, which represents approximately 25% of our California customers. Our GRCs request an increase in our revenue requirement of approximately $11 million in the fiscal years of 2006 and 2007, and $6 million for the years 2007 and 2008.

In our filings, Cal Water is asking for a return on equity, ROE, of 12.23%. In addition, Cal Water has proposed the PUC adopt significant modifications to CPUC rate setting procedures for Cal Water, which I'd like to discuss with you.

First, for these eight districts, Cal Water is requesting a water revenue adjustment mechanism, which operates similarly to the revenue adjustment mechanisms for the electric industry in the State of California. The water revenue adjustment mechanism would allow Cal Water to recover lost revenues when actual water sales are below adopted water sales in the GRC. Likewise, Cal Water would be required to refund revenues if water sales exceed GRC projections.

The water revenue adjustment mechanism would effectively de-couple Cal Water's revenues from variations in customer usage due to weather for these eight districts. Most importantly, the de-coupling from customer usage allows Cal Water to encourage water conservation without the additional incentive of effective conservation, which would reduce revenues, cash flow and earnings.

Secondly, the Company is requesting full cost mailing accounts for our larger districts with a mix of water resources -- or water sources. What do water sources mean? Internally, water sources for us would be water from wells or from reservoirs. Outsources would be our purchase of water from other entities.

Currently, the Company's balance account only captures prices -- price changes for offsettable expense within these districts. It does not capture cost changes due to a change in source mix. In these districts of mixed water sources, purchased water is much more expensive than our own well water. If Cal Water is unable to pump its wells for a variety of reasons, Cal Water is currently unable to recover the higher purchase costs.

Now, I would like John to comment on other requests included in that filing.

Cal Water is also requesting a rate-based equalization account. Cal Water is requesting all customers to pay into an equalization account which will fund the higher cost of capital due to higher rate base on average in some of its smaller districts. This proposal is needed as water quality requirements have caused rate base to far exceed Cal Water's average rate base per customer in its smaller water systems, and are driving significant rate increases where a large number of customers are on fixed income.

Finally, Cal Water has requested that the PUC consider a number of factors in setting rate of return. Most importantly, Cal Water has asked the CPUC to consider the additional risk due to the impact of new procedure put in place by their decision 0306072, which limits the recovery of offsettable expenses by an earnings test. The earning test restricts any district with increasing offsettable expenses from earning above its authorized rate of return.

The procedure is biased against the utility. Cal Water has been denied 1.9 million in rate relief in 2002, 900,000 in 2003 and 700,000 in 2004 due to this procedure put in place by this decision.

Cal Water has also requested recognition for the risks associated with well production costs. With stricter water quality and operating standards, wells must be taken offline to resolve operating problems, which requires using the more costly purchased water as replacement water.

With that, I'm going to turn it back over to Bob.

As I mentioned in our prior conference call, the CPUC has two new commissioners -- Dian Grueneich and John Bohn. And Cal Water is anxious to discuss with them these proposed changes at the appropriate time. Cal Water is encouraged that the new commissioners have shown an interest in water issues, and believe that they will be receptive to the changes proposed, as such changes promote water conservation, are consistent with the statewide water policy and will reduce costs to our ratepayers in the long run.

I would like to now discuss two organizations that are assisting Cal Water in this regard. First, Cal Water has been an active participant with the California Water Association, better known as CWA. CWA is a 64-year-old organization that represents investor-owned and privately owned water companies in California. The Association has sponsored legislation that has benefited Cal Water and other California water companies.

After a long recruiting process, I'm very pleased to announce that CWA has retained a Mr. Jack Hawkes (ph) to perform the services of an executive director. Mr. Hawkes has 20 years in the utility business. He worked with the American Gas Association, Pacific Gas and Electric Company out here in San Francisco, and most recently with the Electric Power Supply Association in Washington, D.C. Mr. Hawkes brings a depth of experience with state commissioners and utility associations.

We are excited that the association now has a new office in San Francisco. As a matter of fact, the new office is directly across the street from the PUC building, and to be even more specific, right across the street from the CPUC water division. We believe that such a presence will help advance our issues before the CPUC.

Recently, Cal Water joined the California Foundation for the Environment and the Economy, better known as CFEE. The mission of CFEE is to bring together business, labor, community and environmental leadership with legislative and regulatory officials and expert academicians in forums designed to address issues that require creative solutions in an atmosphere of nonadversarial cooperation and a common desire to achieve long-term benefits for all concerned.

Membership is limited, and Cal Water is one of three investor-owned water utility companies on this committee. I mentioned this organization because our regulators are actively participating with open minds and a spirit of cooperation in this very same organization.

Cal Water's membership has given both the Company and the regulators a forum to discuss issues and possible long-term solutions that are important to the Company and the water industry. For example, CFEE is addressing whether current CPUC water policies are consistent with other statewide water policies such as conservation. Again, we are extremely encouraged with what we see at the CPUC, CWA and CFEE.

John, I'm going to toss the ball back to you.

Now I would like to turn back to the third quarter and discuss capital projects and our financing requirements. The Company funded in the third quarter 13.8 million versus 29 million worth of capital expenditures. I want to caution everyone, though, that billings on capital expenditures often do not reflect the actual construction that has been completed. We would anticipate that in the fourth quarter, there would be a reversal.

We're projecting that the Company will spend between 60 and 70 million of its 85 million original budget on capital expenditures this year. As a year to date, we've expended 43 million versus 88 million. As a result of this, we also have 22 million in cash at this time and the full use of our credit line. So we do not anticipate any financing in this quarter, and we would be looking at the beginning of 2006 for any type of debt offering.

I'd like to also update you on our Sarbanes-Oxley 404 review. Our internal auditors and consultants have substantially completed their financial stocks testing and IT general controls. This includes the daily cash reports, data security, new system integration.

We still have to complete some IT application controls, such as PeopleSoft financial report balancing, HR approval of salary changes and our customer information system access and the segregation of duties associated with it, as well as the general office bank reconciliations and some approval of journal entries. We, however, anticipate full compliance by the end of this year, and a review by our independent auditors accordingly.

The next thing that I'd like to discuss it is that we have mentioned it in the past, the gain on sale of non-utility property. Just to update you, it's unfortunate that this issue will not be resolve until the first quarter of 2006. The CPUC has acted to extend the statutory period on the proceeding until January 3, 2006. The administrative law judge assigned to this proceeding lost a close family member, and for understandable reasons, is unable to meet the original scheduled decision date.

With this, I'm going to turn it back to you, Bob.

The Company has announced previously in effect of October 1 there would be changes in Cal Water officer responsibilities. Ray Taylor, who is retiring after 23 years of dedicated service with Cal Water -- most recently he's been our Vice President of Operations. We're happy for Ray and we will miss him. Rob Guzzetta, previously our Vice President of Engineering, will be the Vice President of Operations, taking Taylor's place.

Paul Ekstrom, former Vice President Customer Service and our Corporate Secretary, will be Vice President Customer Service and Information Systems. Dan Stockton, former Vice President of Information Services, will be Vice President Corporate Development and Corporate Secretary. Stan Ferraro will continue as our Vice President of Regulatory Matters, and assume responsibilities for corporate communications.

One of our aims for these new assignments is to allow for more attention to be devoted to corporate development -- in other words, an added emphasis on development. The Company is working with master plan developers on projects in both California and in New Mexico, where Cal Water will be the projects' water and wastewater purveyor.

Cal Water continues to look at acquisitions that meet its strategic objectives. Most recently, New Mexico Water has acquired Cypress Gardens, a small water system adjacent to our Rio communities, with approximately 350 customers per rate case.

In California, the Company acquired the Los Trancos County Water District with approximately 250 customers that interconnect to our Bear Gulch district, which is here on the San Francisco Peninsula.

And, at yesterday's monthly Board of Directors meeting, the Board declared a dividend of $0.2850 per common share. It will be payable on November 18 to stockholders of record on November 7. 2005 marks the 60th year that Cal Water has paid a dividend. That is the 38th consecutive year where we have increased our dividend.

Now I would like to open it up for questions from you, the analysts. But before I do, is there anyone aboard who's from Chicago? If that is the case, I congratulate you on the White Sox. The balance of you, please share my condolences. Now for your questions.

(OPERATOR INSTRUCTIONS) David Schanzer, Janney Montgomery Scott.

Just a couple of questions of clarification -- I thought your call was quite complete. The effects of weather were approximately $0.02 on earnings. Is that a fair assumption?

For the quarter? The weather effects were down slightly. I would say 1 to 2.

Then lastly, the other question I had was more a question of philosophy. The dividend payment, would you expect over the next 12 months any change in the Company's overall direction as far as dividend policy?

I think obviously we believe in the consistent payout of dividends, and that's all I'm going to say there. I think our past history speaks for itself. I think better to leave that alone. By the way, Dave, on December 3 of this year I'm going to be back in Philadelphia for the Army-Navy football game. So look out.

Drop by and say hello. Good talking to you.

(OPERATOR INSTRUCTIONS). Selman Akyol, Stifel Nicolaus.

Not from Chicago, but from St. Louis, and thoroughly enjoyed the defeat of Houston. I would just ask you, could you please just review the mix on the purchased water versus the well water, and which way they moved?

Certainly. Let me get back to my notes there. The mix -- this is for California. Our subsidiary systems are all 100% well water. In California, the water -- purchased water decreased from 46.5% to 45.9%. As a general rule, the purchased water, of course, is more expensive than when we pump it and treat it ourselves. The well production increased to 50.8 from 49.9, and the surface water remained at 3%, same as last year.

Thank you so much.

(OPERATOR INSTRUCTIONS). Steve Gambuzza, Longbow Capital.

I was wondering if you might comment again on the timing of some of the regulatory actions you spoke of, specifically you have some of the proposals to improve your recovery of purchased water costs. How will that unfold over the next couple of months?

This is John Tootle. We filed our -- as Bob indicated, we filed our rate increase. And in California, the commission is to put into effect rates by the first day of the first test year, which would be for us July of 2007 -- I'm sorry, 2006 -- for the fiscal year 2006-2007. And so we would imagine that they would've made a decision on those proposals that we discussed in that rate case, and by that time. In addition to the rate case, we of course have other filings out there with the California commission. Those are for recovery of balancing accounts, and as of the end of September, we had basically about $4 million worth of accounts, for which we were awaiting approval on.

You said these filings, the general rate case is for eight districts?

Right.

And what percentage of your total rate base in California is that?

It's about 25% of our customers.

To your knowledge, have there been any other proposals put forth in front of the commission by other public utilities in California to amend the procedures for recovering purchased water costs that are similar to the ones you're putting forward, and how has the commission responded?

No, I would say at this point as far as the water revenue adjustment mechanism, we're probably the first company to propose this formally. As far as the full cost balancing account, some companies have requested it, and some companies have been granted it. As a matter of fact, we have a full cost balancing account in one our districts.

When might the staff file a rebuttal against your proposal on this initiative?

We would expect that would be early in 2006.

Thank you for your time.

(OPERATOR INSTRUCTIONS). Debra Coy, Sanford Washington.

Bob and John, if you could just take a step back and kind of tell us where you are on your overall capital spending programs and rate case increases to cover that CapEx. Certainly, you've been through a long, long drought, if you will, in terms of the timing of recovery from the CPUC. It seems like the overall environment has improved. You do have $4 million of rate case recovery that has benefited your current quarter, and you have an $11 million rate case filing out there now.

Could you give us a sense of where you are in the overall capital spending programs and recovery process? In other words, have you gone through most of your districts and done the CapEx you need to do, or are you catching up? Do you still have a fair amount ahead? Can you give us sort of a recap of where you've been over the last two years, and what the next two years looks like in terms of CapEx and rate case recovery that you need to do?

Certainly. First off, let me address the expenditures. As we expressed in our prior conference call, this year, the Company is having to meet the arsenic standard. And that will actually take effect in January of 2006. So we are in the process of putting the capital in the ground, making those switches from sources which contain arsenic to those which we can blend and get below the MCLs. We're doing that this year in preparation to meet that standard in January. So I would say that this year probably was a little bit on the -- should be a little bit on the higher capital expenditure side. But we're projecting (multiple speakers)

What kind of CapEx number for this year?

We're looking at about 60 to 70 million. We originally had a budget of about 85. I don't think we'll get that all completed. Next year, I think it will be substantially similar because we did of course have to put some other projects probably on the back burner while we moved arsenic to the front burner. So it will be a little bit of catch-up again next year, but then after that, I would think that it would possibly settle back slightly.

As far as rate relief recovery, last -- the rate case that we got a decision on in July in which we got a 7.6 million increase, that was for about 50% of our customers. And in California, we file for eight districts every three years, and we have 24 districts. So this year we're filing for 25%, and the eight districts. Next year, we'll file for another eight districts with about 25%, and the year after that, those districts with about 50% of our customers will be in the general rate case queue. Does that --

That helps. So basically, what you're saying is that the 11 million upcoming is another 25%, and the next big piece comes in '07?

Yes.

All right, that's helpful. Thank you. And of the rate case that you received in July, that obviously did not include any arsenic spending recovery.

No, it did. Some of it was included in rates, and some of it is by advice letter filing. And off the top of my head, I can't remember what the amount was in the advice letter filings.

That does help, thank you.

It was a significant amount, so once we get that capital in, we will be able to apply for rate increase associated with that capital.

And you don't really see any other significant environmental regulations that are having quite the same effect, like the disinfection filtration -- disinfection byproducts and filtration rules won't have the same effect on you as the arsenic rules?

Both Bob and I would like to say no, but we've been in this industry long enough to know that if we said no, this afternoon, we would hear about a new contaminant. We are in a business where you can expect that we will always be trying to do a better job and meet -- deal with these contaminants as technology allows us to address them. And I think that's about all I can really say there.

That's helpful, thank you.

I'm sorry I'm not going to be able to make the NAWC conference.

So am I, Bob. Francesca is going to be there.

We knew that. Maybe next year.

Yes, absolutely.

(OPERATOR INSTRUCTIONS). I'm showing no further questions here.

Do you want to wrap it up?

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Thank you, and have a nice day.

Thank you.

Thank you.